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LOANS TO ASSOCIATIONS

Associations sometimes need to borrow money for special projects. This can include capital improvements such as building fences where none existed before or making needed repairs where there are insufficient reserves to cover the cost.

Authority to Borrow. The authority for associations to borrow money is generally found in their governing documents (bylaws or CC&Rs). It can also be found in Corp. Code § 7140(i), which allows corporations to obtain bank loans subject to any limitations found in the governing documents.

Collateral for Bank Loans. Directors should never personally guarantee loans made to the association--directors are volunteers and should not be putting their own assets at risk for such loans. For bank loans to associations, banks require a different form of collateral. Most often, it's a special assessment approved by the membership that serves as collateral. (Civ. Code § 5735.) If, for some reason, the association defaults on the loan, the lender can step into the shoes of the association and pursue payment from the membership. If the bank requires a lien be recorded against the common areas as security, it means the bank is unfamiliar with how associations work and the board should contact other lenders.

Membership Approval. Check your documents before you apply for the loan. Membership approval of the special assessment (for a capital improvement, repairing the common areas, etc.) may not be enough. The ballot may also require approval authorizing the board to enter into a loan agreement with a bank.

Loan Checklist. Following are issues that boards need to be aware of:

  1. Term. The term for bank loans is generally 3, 5, 7, 10 or 15 years depending on the size of the loan.
  2. Credit Metrics. Before approving a loan, banks look at the association's (i) owner delinquencies, (ii) cash balances, (iii) percentage of renters, (iv) reserves and other factors that may affect the stability of the association and its ability to repay the loan.
  3. Collateral for the Loan. Generally, a special assessment approved by the membership serves as collateral for the loan. Board members should never personally guarantee the loan.
  4. Application Fees. Some banks charge application fees, some do not. You should ask before you apply.
  5. Bank Deposits. Sometimes banks require associations move their operating and/or reserve funds to their bank as part of the loan approval terms.
  6. Financial Statements. Associations must provide financial statements and disclose delinquencies. If your association has high delinquencies and/or failed to comply with statutory requirements for annual financial statements, it is unlikely you will be approved for a loan.
  7. Good Standing. Associations must be in "good standing" with the Secretary of State before they can get a loan. That means filing income tax returns and paying taxes. Boards can go online to check their status with the Secretary of State before initiating the application process.
  8. Insurance. Lenders sometimes ask about the association's insurance. Boards should check with association's insurance broker to make sure they have insurance that meets or exceeds statutory and CC&R requirements.
  9. Authority. Boards will likely need authority to borrow in their documents and/or approval from the membership.
  10. Attorney Opinion Letter. Banks normally require an opinion letter from the association's attorney as part of the loan approval process. Some require review by the lender's legal counsel rather than the association's. Boards should involve their HOA attorney from the outset to advise them about the approval process and to prepare the ballot to the membership, if needed. Your attorney must express an opinion to the bank about the association's authority to borrow.
  11.  Prepayment Penalties. Will the loan have prepayment penalties? Avoid them if you can. Also, the board may need to set a policy regarding prepayment by owners upon sale of their units.

Prepayment Issues. If prepayment is allowed without penalties, does it reduce the term of the loan or reamortize the loan? You want it to reamortize the loan so that loan payments are reduced. This issue will become important as units are sold. Frequently, buyers want the seller to pay off their portion of the special assessment so the buyer will not have to make payments.

Reamortize? Boards have discovered that prepayments create problems if the loan does not reamortize since the association must continue making the same loan payments to the bank but with less money from the membership for that purpose. This results in operational funds being diverted to the loan payments which, in turn, results in higher assessments for everyone as the board is forced to increase dues to cover the shortfall.

Adopt PoliciesTo avoid this problem, boards can adopt a policy against prepayments by members and require buyers to assume the assessment payments of the seller. To adjust for this, buyers and sellers can negotiate arrangement between themselves such as lowering the purchase price by the amount of the special assessment or leaving that amount on the table for the buyer to use as he or she wishes.

ASSISTANCE: Associations needing legal assistance can contact us. To stay current with issues affecting community associations, subscribe to the Davis-Stirling Newsletter

Adams Stirling PLC